Do Investors Deserve to Make Money?

The following is a guest post from Marotta Wealth Management.

Many people believe the rich inherit great fortunes and then sit idly by while their stocks make them more money. When you're working long hours, this belief can provoke jealousy and inspire questions like "Do investors even deserve to make money?"

To respond, we must first define ownership, which is best thought of as a set of rights. When I own something, I decide what to do with it. I have dominion and authority.

Your autonomy is only limited by your duty to respect the autonomy of others. Just as you have a right to act however you see fit, so do others. If you infringe on the rights of another without permission, you are acting in the wrong.

In their paper "The Biological Basis of Human Rights," Hugh Gibbons and Nicholas Skinner argue that the biological basis for legal wrong is "actions that, if undertaken, will diminish the will of another human."

This self-ownership is then the basis of all our other rights including property rights. Ownership is "self-propagating," meaning that the rights of ownership transmit from property to its products. Because you own yourself, you also own the fruits of your labor.

For example, when you make a stew, your efforts produced the food and you also own the product. The same goes for my chicken. I own the eggs the chicken produces just like I own the chicken. This is the right to property. With this ownership, I can trade my rights of ownership of goods for the rights to own something else.

Before currency, the product of my labor was the only way I could acquire the product of your labor. In a barter system, I trade my chicken or the promise of my chicken for your stew. If I don't have any goods you want, I can't acquire the rights to your stew.

However, in today's monetary system of trade, instead of getting an inherently valuable good as a reward for my labor, I get money. This money is just a placeholder of my labor not yet rewarded.

When I work my 9 to 5 job and earn a paycheck, I receive a paper certificate I can trade in for the real reward of my labor. Instead of trying to guess what a farmer really wants for his chicken, I can give him a monetary certificate for him to use as he wishes.

So long as his payment remains in the form of currency, his labor in raising the chicken has still gone unrewarded. But when he uses that money to buy chicken feed or dinner for his family, he is finally reaping the reward of his labor.

Workers can delay the reward of their labor in many ways, sometimes indefinitely. One obvious method is loaning money to someone else who needs it because he either has not labored enough or not saved enough. When you loan someone your money, you are essentially loaning your labor.

Hard work was required to earn that money. Because you let this labor go unrewarded, you are now able to let the money, in some sense, work for you. By making the loan, you allow him to reap your labor's reward first. In return for this privilege, he pays you back with interest.

Another way to prolong the reward is buying stores of value like real estate, precious metals, collectibles and stock ownership. Each of these stores the value of your reward. Unlike an ice cream cone where the value is either consumed immediately or lost, stores of value safeguard your ability to be rewarded for your labor at a later time.

If the value does more than remain constant but increases regularly, the store of value is an investment. Rental property and stock ownership as well as owning a private business are all common investments. Each one tends to increase in value over time.

Like loaning money, buying investments defers the reward of your labor while earning you more reward.

If I run my business well, the reward from my business will increase beyond its purchase price. If I run my business poorly, the certificates of labor I spent will forever go unrewarded.

In a business where the only employee is the owner, he obviously deserves all the profits. He is the one who invested money into it and the one laboring for it.

A restaurant is a more interesting example. Often one owner has hired employees to host people, bus tables, and cook and serve the food. The owner may not work in the restaurant herself, but she will still receive all of the profits.

From those profits, the owner pays her employees, mortgage or rent, bills and her own salary. She deserves a portion of the profit because she owns the store. Her unrewarded labor is at the heart of the value of the company. The present reward for the work done in the past is the store. Just as you own yourself, you own the fruits of your labor. So too when you own a store, you own the fruits of your store.

Imagine this restaurant owner decides to sell her business. A man comes along and buys the place outright. A trade occurs when the previous owner's unrewarded labor is freed from the store while the new purchaser's unrewarded labor is sunk into it. The new owner deserves the fruit of his property's labor just as much as the previous owner did. Even though the previous owner was the one whose sweat equity built the company, she sold her right to ownership. With that right, she transferred the right to the fruits of the property.

Stock ownership works just like this example. Only instead of investors buying companies outright, they are buying the tiniest percentage of a publicly traded company. Their share of the ownership means they are due that share of the profits. Their unrewarded labor, their money, has bought them a store of value.

Investors defer consumption of their reward to get bigger and better compensation in the future. This system of property rights is not only responsible for civilization as we know it but also the most mundane aspects of financial planning.

For example, deferred consumption is the basis for all retirement planning. Taking care of our own retirement requires being able to store the value of our labor in property that not only safely stores the present value but can beat inflation by continuing to produce more value. Nothing can replace this. To consume your reward later, a financial vehicle is needed to carry that value into the future.

That being said, sinking all of your retirement aspirations into one business might jeopardize those dreams. Small business owners often make the mistake of pouring all their resources into the business they understand best where they have the most control. But every business is at the mercy of macroeconomic changes, and small business owners benefit from diversification.

Property rights give our society the basis for financial security. Some have even argued that property rights are more critical to civilization than democracy. Everyone can benefit from the ability to buy and sell what they own, even minority business ownership.

Comments

[getagrip]

So to answer the initial question, in your opinion investors deserve to make money. I agree, but disagree with subtle meaning impled that we aren't supposed to feel jealous or think that's wrong regardless of circumstance. Hmmm.

How does all this talk about ownership keep me from becoming annoyed at some 20 something know-it-alls telling me to be sure to only feed my children free-range chicken and pure organic food from the back porch of their Mommy or Daddy's multi-million dollar beachfront property, which unfortunately is close enough to the public beach I'm on that they feel they need to subject me and others to their wisdom before they leave the next day for their ski trip in the alps where, by the way, one of them is horribly put out because Daddy is using the private plane and they have to fly first class? Where did the fruit of their labor grant them ownership and how did they gain value in it again?

How does it justify a CEO or Board member who trashes a company's value, affecting the bulk of the employees retirements and livelihoods through their actions, getting a huge bonus and severance package as they exit?

How about the board of BP, who even though they had a dozen deaths, a major oil spill, and crapped up the Gulf affecting millions of people, were still getting their safety bonuses because they hit their numbers for the year across the company (after the bad press they donated the bonuses, but the fact is that corporate structures are set up to reward this way)?

How does it justify a company that is making a profit being forced to close shop because they just aren't making enough of a profit to meet their quarterlies, leaving hundreds jobless and essentially gutting a community?

Need I even mention the 20 year person who's working their way up through a company only to get knocked out of a promotion by a fresh out of college or zero knowledge of the business son/daughter/cousin/buddy/etc. of someone up the chain. Fruit of their labor, how's that work again?

My problem isn't that an investor in a company, taking a risk, gets a reward. My problem is that often there appear to be NO risks for a large chunk of the very well off. They are compensated where we would be destroyed. They are forgiven where we would be cast aside. They are incentivived when we are left destitute.

So excuse me if I get aggrivated, jealous, envious, and judgemental of people who in my view assume they deserve what they themselves have never actually earned via any real labor on their part but that somehow through luck of birth, lack of ethics, or poorly negotiated agreements take their fortunes not only for granted but assume it was their right to them from the beginning. Even if they are, hopefully, a minority.

Sigh, I have to go take a chill pill now, I'm starting to see green :-)

[Lurker Carl]

Big rewards command huge risks, doing nothing to maintain their fortune is the biggest. Conspicuous consumption, lousy judgement and inflation are only three of many traps that devour it. To find out how famous fortunes are made and squandered, read about folks like the Vanderbilts and Dodge Brothers and Kennedy clan and Mike Tyson. Your envy and jealousy will turn to pity and anger.

[NY23inMD]

The article by Marotta Wealth Management is a good discussion of the concept that money value and wealth is primarily labor based, a dollar bill represents some amount of unrewarded labor. The article is largely "positive" as it does not make any strong value judgements between those with wealth and those without. If you are an investor, big or small, or someone involved in making public policy decisions, this is a concept you need to keep in mind.

Nonetheless, I can sympathize with those who find the growing gap between the haves and the have-nots a problem. I think management skill should be highly rewarded, but when top management makes more than 400 times the average worker in a company, I have a problem. When millions or billions in estates get passed on to heirs and they complain about "death taxes", I have a problem. When top athletes and top entertainers make tens of millions, while low-income fans cough up hundreds of dollars apiece for an event, I have a problem. There are huge implications for social and economic justice that could eventually lead to national decay.

The trick is to maintain the clear benefits of individual initiative and private markets, while making sure these benefits are broadly shared. This is what much of our current national debate is about.

[sb]

To add on to what getagrip said (which I agree with, but maybe not with the same passion :P), another example of investors lack of risk is the downturn in the economy a few years back. Yes, many people lost a lot during this time, but the ones who stood to lose the most because they were taking the biggest risks were bailed out and saved. They were able to reap the benefits of the risk for so long, but when that risk comes back to bite them, it just disappears.

That being said, I hope my investments do well...

[jim]

Yes we agree its ok to own a chicken and sell chicken eggs.
Thanks.

Whats the other side of this argument? Did someone claim that nobody should ever make money? It starts out by saying many people think the rich inherit their fortunes, which isn't true. But then goes on a tangent about how its ok to sell eggs from your chickens.

Is Marotta trying to convince a 1920's era communist or a 16th century Native American that capitalism isn't a bad idea? Or is this 'capitalism is a-ok' rudimentary primer meant to justify any/all excesses and abuses by anyone whos rich? Is this trying to justify wealth inequality?

[Erik]

Thanks Jim. I had the same thoughts when I read this peace. I have no idea what the point is of this article. Was this article meant for the occupy wall street crowd?

[Derek @ MoneyAhoy.com]

I think the long terms capital gains rate should be increased back to ~30% like it was in the past. Since this rate has been reduced, we have seen the wealth gap increase to such a large amount that we're headed for another depression...

[Sarah]

I've always thought that these Marotta posts bring down the level of sophistication of this site considerably.

[Old Limey]

I agree with Sarah.

[so]

I second Sarah / OL.

[freebird]

I would agree that investors deserve to make money but I would not agree that these earnings should be taxed differently than earned income as is the case now. I'm sure you have retired clients who carefully prune their portfolios every year to minimize the tax hit, and that some of them may be pulling in nearly six figures in passive income and paying almost zero income tax thanks to the magic of long term capital gains and qualified dividends. It's all perfectly legal according to a tax code that essentially assigns a zero cost basis to a person's time. In my view labor is bearing a disproportionate share of the tax burden, and this is the fundamental injustice in our present system.

[SR]

I think this discussion is outstanding including the comments as well as the article. There are so many good points. The topic of wealth inequality seems to be slowly bubbling to the top of the nation's agenda and it is reflected in the comments here.

On the one hand, I resonate with the article's point that investors do, in fact, deserve to be justly rewarded. On the other hand, I sympathize with those who are illuminating the growing wealth inequality in our country and around the world.

One potentially insightful perspective that hasn't been discussed yet is the proportion of profits (or reward) going to investors at the expense of all other parties. I am both a worker and an investor. As a worker over the past 5 years, I have been in the middle of a pretty ugly landscape. There has not been much wage growth and there is a constant fear of losing one's job. As an investor almost exclusively in public stocks, I have seen my net worth triple. What a contrast.

It is very clear to me that the people holding the reins at public companies have enough power and control to maintain profit margins even during a significant economic downturn and subsequent recovery. I have to admit that I think the wealth I have received in the last 5 years as an investor has been over rewarded and somewhat unjustified. When I see others struggling, I admit there is some guilt.

At the risk of stating the obvious, I think capitalism in the current form that we are practicing will always reward the top percentage of society who are lucky enough to be there. From a purely capitalist and performance perspective you could argue that it is justified, from a moral perspective not so much. It is coming to a crossroad. Any more events that increase suffering on the majority will drive the urgency of change. How do we evolve? Something like the conscious capitalism movement headed by John Mackey and others seems to make sense to me. What are your thoughts?

[JayCeezy]

@SR, glad your portfolio is doing well in the past 5 years. As for your NW "tripling", it sounds like you might be quite young; $10K to $30K is a lot more doable than $1mm to $3mm.

fwiw, the 50% S&P 500 decline in 2000-03 and the 57% S&P500 decline in 2007-09 might give you a different perspective on risk/reward. Your experience as an investor is great (for the past 5 years), but let's face it; workers are pretty expendable. There is nothing very special about a U.S. blue-collar or white-collar worker, as the rest of the world catches up in education and surpasses us in work-ethic. And the difference in a salesman, accountant, or engineer with 10 years experience compared to 30 years experience is not worth the compensation premium of 20 years of 3% salary increases.

The idea of a broad middle-class in any civilization is really less than 100 years old. This trend of the 'wealth ladder' extending and concentrating at the top isn't changing, and won't change no matter how the arguments are framed (moral, political, merit or inherit, etc.). I'm done waiting for things to 'get more fair' or for politicians (and my fellow citizens) to do anything other than look out for themselves. I'm acting accordingly (saving as much as I can, paying down debt, working as much/hard/smart as I can). Those are my thoughts.

What 'crossroads' do you foresee? What 'urgency of change' makes sense to you? Your thoughts are appreciated.

[Old Limey]

JayCeezy
I couldn't agree more but I'm surprised that a youngish person has thought this through and arrived at the situation that I read about happening all the time. At 79, none of this affects me which allows me to be very objective. It's very sad how things are looking for young people these days and it's so different from when the Cold War was going full bore, jobs were plentiful and most things that I bought were stamped "Made in the USA".

[SR]

JayCeezy,
I am flattered that you think my writing is youthful :) No, I've been investing for 25 years now. Slowly putting it away at a steady pace. You did catch me cherry picking my time frame to dramatize my point, but I think the point is still valid. The S&P 500 was at 689 in March 2009 and today it stands around 1700. Who has done better since March 2009 - laborers/wage earners? or those who deferred compensation and invested in stocks? It's not even close.

In addition, I would argue this has been true for decades. For example, I have now made more money by deferring my compensation and investing in stocks than the average laborer will make in a lifetime. This is not to say I am special. You will have to trust me on this, I am not very special.

The crossroads I am talking about is the growing public awareness or general dissatisfaction with this situation. There is an underlying anger even though they don't fully understand the system and how it works. If they did, they would start investing immediately :) I saw articles in the USA today, WSJ and NY times in the past two weeks on this very topic. I've seen picketing at McDonalds, WalMart and lets not forget Occupy Wall Street.

I am not good at predictions but let me lay out a scenario that isn't out of the realm of possibilities. An organized effort is put in place via social media (facebook, twitter, etc.) where a company, let's say McDonalds, is boycotted for a week because either they don't pay their workers enough or their CEO makes too much money. And, let's say that this boycott impacts the comp sales numbers. The stock sinks maybe bringing down many others with it. This success leads to another and we have the whole market in trouble. Since McDondalds numbers are hurt they decide to layoff some employees. It's very easy to see how this could turn into a vicious circle. A kind of ' corporate revolution'.

I agree that from a business performance perspective many workers today are expendable. I would also argue that this is the problem that needs to be solved. For those are the people that make the system run. You cant have your 11% annual returns without 'em. You have to take care of the whole system.

[JayCeezy]

@SR, regarding cherry-picking the last 5 years, fair enough. If you consider the S&P500 return from January 2000 through today, the annualized return is 1.25%. Almost 14 years. If you adjust the return for inflation and add dividends, the return is .67% per year. 14 years, less than 1% a year. http://dqydj.net/sp-500-return-calculator/

The period you cherry-picked has also received a subsidized return through the Fed's ZIRP. It would be an interesting intellectural exercise to discover what real returns without ZIRP would have been. Investors holding equities may have done well, long-term real estate holders and cash investors, not so much. In any event, I'm not seeing 11% returns going forward and certainly didn't have your investing acumen.

There is no argument that there is wealth inequality, and it is growing. Other than redistribution, the government is powerless to slow this problem (it won't be reversed). Your scenario is very plausible. My only thought is people like McDonald's, and keep eating there despite many continued attempts to demonize McDs.

What I consider another likely scenario is a growing population of unmotivated people without education or skills to get and keep a good job. The govt. will continue to subsidize a subsistence level so people just maintain a feeling of discontent but won't get off the couch and tune away from "The Voice" in order to revolt.

Kids are expensive, for parent(s) and society. Very few of us (I'm also less than special) really "pay our way" with taxes and social/commerce contributions. My admittedly controversial partial solution would be to subsidize people to not have children. That isn't going to happen, though. My prediction is a continued decline, and in the end it won't even be worth crying over.

Wow, that was a bummer post. I'll try to end with some cheer, and say "have a great week!":-)